An advertisement for Microsoft Corp's Windows Phone in Barcelona, Spain. The company's purchase of AOL Inc's patents shows the litigious environment of the industry, according to experts. [Denis Doyle / Bloomberg]

Microsoft purchases portfolio amid industry intellectual-property war

AOL Inc, under shareholder pressure to make changes as revenue shrinks, agreed to sell and license patents to Microsoft Corp in a transaction valued at $1.06 billion, triggering its biggest stock gain in two years.

AOL rose 43 percent to $26.40 at the close on Monday in New York, the biggest one-day increase since Nov 25, 2009. The shares had lost 8.2 percent of their value in the past year before Monday. Microsoft, meanwhile, fell 1.3 percent to $31.10 on Monday.

The arrangement, which will give more than 800 patents and related applications to Microsoft, lets New York-based AOL generate additional funds amid slow advertising growth and a decline in dial-up Internet subscribers. AOL, whose revenue has dropped 29 percent since it was spun off from Time Warner Inc in late 2009, has faced pressure from shareholder Starboard Value LP to consider moves such as a patent deal.

"Few people were anticipating that they were going to generate $1-billion-plus of cash," said Tom Forte, an analyst at Telsey Advisory Group in New York. "The company has done an incredible job of creating value from their patent portfolio."

Microsoft, the world's biggest software maker, is adding the patents as it tussles with Motorola Mobility Holdings Inc in the courts to protect intellectual property rights related to the Windows Phone operating system and Xbox video-gaming consoles. Technology giants such as Apple Inc and Google Inc also are building patent war chests in an effort to fend off litigation and defend their products.

More artillery

"They're building up their ammunition," said Ed Maguire, an analyst at Credit Agricole Securities in New York. Microsoft may need the patents to go after the manufacturers of Android handsets, which license the operating system from Google, he said. "It's certainly worth Microsoft's time and resources to go out and acquire something that lets you extract money from the Googles and the handset makers."

Microsoft gains nonexclusive license to AOL's retained patent portfolio, the companies said on Monday in a statement. AOL will hold more than 300 patents and applications after the transaction.

Microsoft, which had $52.7 billion in cash and equivalents last year, is trying to keep the patents away from competitors, said James Conley, a professor at Northwestern University who studies patents.

Litigious industry

"The fact that AOL was able to get the money it did as fast as it did for its patents, and from Microsoft, is an indication of how litigious the space has become," said Anthony DiClemente, an analyst at Barclays Capital Inc in New York.

Kevin Kutz, a spokesman for the Redmond, Washington-based Microsoft, said the company isn't ready to comment on what the patents cover or what the company will use them for. Microsoft historically has used patents more for licensing than lawsuits, he said.

Tim Armstrong, AOL's chief executive officer, said he expects the license arrangement with Microsoft to generate $100 million over the life of the patents.

"This strengthens our ability to give more resources back to shareholders," Armstrong said in an interview. It "allows us now to have a clear focus on operating our core strategy of turning brands into businesses".

AOL reached the agreement late on Thursday after an open auction, with many companies submitting bids, Armstrong said. He declined to identify the other bidders.

Shareholder rewards

AOL said it plans to return a "significant portion" of the sale proceeds to shareholders. Had the patents changed hands last year, AOL said it would have had about $15 per share of cash on hand as of Dec 31. The company ended last year with $407.5 million in cash and equivalents, down 49 percent from 2010.

Starboard, which started pushing for change last year, had said AOL's patent portfolio could yield more than $1 billion. Patent-advisory company M-Cam Inc estimated that AOL's patent portfolio would only be valued at about $290 million in a sale. Jeffrey C. Smith, Starboard's co-founder and CEO, declined to comment on the Microsoft transaction.

Shareholders have called for AOL to turn around investments in the Huffington Post, acquired as part of a $315 million transaction last year, and Patch, whose local news sites are designed for communities with populations of 15,000 to 75,000.

Patch may have lost as much as $150 million in 2011, based on fixed expenses of $160 million and an "immaterial" revenue contribution as low as $10 million, Starboard said in December.

No acquisition

"They will probably not be using the cash to make a major acquisition or invest in Patch in a bigger way, for instance," said Clayton Moran, an analyst at Benchmark Co in Delray Beach, Florida. "Not only is the search business hindering revenue growth, but their display business is losing share as Google and Facebook bring in cheaper inventory."

AOL has struggled to revive revenue growth after separating from Time Warner, as the company competes for advertising dollars with Google and Facebook Inc. AOL's sales declined in each quarter last year, and revenue this year is estimated to drop 3.7 percent to $2.1 billion, according to analysts' projections compiled by Bloomberg.

Armstrong had been in talks with private-equity firms as recently as September, when the CEO approached potential financial partners about combining AOL with Yahoo Inc, two people said at the time.

Starboard had a 5.2 percent stake in AOL as of February. The fund said in a Feb 24 statement that it was "increasingly uncomfortable" with the direction AOL and the board leadership are taking.

Evercore Partners Inc and Goldman Sachs Group Inc acted as AOL's financial advisers, and Wachtell, Lipton, Rosen & Katz and Finnegan, Henderson, Farabow, Garrett & Dunner LLP gave legal counsel. Covington & Burling LLP advised Microsoft.

Under the terms of the deal, Microsoft will have to pay AOL a fee of $211.2 million if it chooses to end the transaction. The deal is expected to be completed by the end of 2012, upon receiving regulatory approvals.

Microsoft has accused Motorola Mobility, the mobile-phone maker being acquired by Google, of infringing seven patents and is seeking to block US imports of devices that violate its intellectual property rights. A US trade agency is reviewing a judge's finding that only one of those patents was infringed.

Separately, Motorola Mobility has demanded $4 billion a year in patent royalties for use of technology critical to functioning of the Xbox, Microsoft said in a March 30 filing.